IT WAS just a few months into the presidency of Barack Obama that America crept out of the Great Recession and into the current expansion. With just three months to go in his second term, Mr Obama seems likely to pass that expansion on to his successor. But what are they odds that she will make it through a four-year term without a brush with economic contraction? The Wall Street Journal polled 59 economists to get their view. They reckon there is a 60% chance of recession striking within the next four years. Is that a reasonable estimate? Let’s consider a few facts about expansions and recessions.
1) This expansion is getting up there in years, by American standards… The recovery began in June of 2009, which means that we are currently in its 88 month. According to NBER, which maintains a list of historical recessions going back to the mid-19th century, the current expansion is the fourth longest on record. The third longest, at 92 months, was the great boom of the 1980s, which the Obama boom can surpass in March of next year. Then comes the 106-month expansion of the 1960s, and finally the Clinton boom of the 1990s, which lasted a full ten years. If it continues, the current expansion would become the longest in America’s history in July of 2019, just over two years into the next presidential term.
2) But not necessarily by global standards. That’s not quite right. A decade-long boom is still a long boom by global standards. It just also happens to be considerably shorter than the longest booms on record. A number of other rich countries have enjoyed expansions lasting much longer than ten years in their history. The Netherlands holds the record for longest expansion, at nearly 26 years, but Australia’s current boom is closing in on the lead.
3) Expansions do not die of old age. You might think they ought to, but they seem not to. That is, according to a recent analysis of postwar business cycles, expansions in their 80th month are no more likely to end in the next year than expansions in their 40th month. The mere fact of having been around longer does not make a boom more likely to end.
But end they do, so what’s going on? Booms appear to meet three sorts of demise. The first is a shock that policy-makers fail to offset entirely. Crisis might break out somewhere in the world, triggering a financial panic or putting a chill on spending and investment. If central banks and governments do not respond quickly enough and powerfully enough, the shock becomes a recession. The second death is something like euthansia: a recession brought on (more or less) intentionally in order to bring an overheating economy back to earth. The classic example is the Volcker recession of the early 1980s. The third death is like the second, but accidental. Since the victory over inflation won in the early 1980s, recessions have invariably come at the end of central-bank tightening cycles; central bankers attempt to merely prevent an episode of overheating but end up turning the screw one too many times.
Some economists would say, not without some justification, that these are all actually the same variety of end: death by tight monetary policy, motivated at least in part by concerns about inflation. Think about the Great Recession, for example. It came at the end of a Fed tightening cycle, which almost certainly contributed to the severity of the housing crisis. It was as severe as it was because of the shock of the financial crisis; but, the Fed underresponded to the financial crisis because soaring oil prices in the summer of 2008 kept inflation fears alive.
Whether one thinks the Fed was the arch-villain behind the Great Recession, or a hapless accomplice, or merely an ineffectual would-be rescuer, we nonetheless have a decent mental model for how the next recession will start. Some shock will probably play a role, policy will underrespond, and the decisive factor will be the vulnerability of an American economy kept from growing too explosively by a Fed hellbent on tightening. We learned this week that the Fed’s decision not to raise rates in September was a very close shave indeed. That’s pretty remarkable; after all, it has been years since the American economy has threatened to produce sustained inflation of 2% or more, and it certainly isn’t red-lining now. Wage growth also remains tepid, and there are vulnerabilities galore across the global economy, from Brexiting Britain, to shaky European banks, to an unsteady Chinese economy. Despite all this, markets reckon the Fed will hike in December.
I think the American economy could easily avoid a recession over the next four years given the right macroeconomic policy. But the right macroeconomic policy, especially when so much of the world is stuck with near-zero rates, is to err on the side of faster growth and above-target inflation. Given that it is harder now than in the past to offset a spate of bad news or a drag on growth blowing in from abroad, it makes sense to keep a stronger head of steam than one might otherwise choose. That is not the way the Fed sees it, unfortunately. As a result, I’m inclined to agree with the Journal‘s economists; America is more likely than not to fall into recession during the next presidential term.
Really? But wouldn’t we see some sign of economic trouble brewing if that were the case? No, we wouldn’t. That’s fact number four.
4) Recessions happen when you don’t expect them. Or more accurately, you can’t see them until they are right upon you. In the growth forecasts it makes every April, for example, the IMF has never once foreseen the onset of a recession in the next calendar year. Even in its October forecasts it only correctly anticipates a coming recession about half the time.
So deep was the Great Recession that American workers have only just begun to enjoy significant benefits, in terms of rising real pay, from the ongoing expansion. It would be a tragedy for those gains to be cut short prematurely. A careless Fed might land the country, and the next president, in just such a mess.